Wednesday, September 29, 2010

Does luck really matter?

The article makes valid points that the time at which you start saving and investing and the time you retire have a material impact on the success of your financial plan. This is not exactly new. Sam Savage (among others) has made this point before.

While the effect of return on investments in the early years of retirement (in particular) can have a dramatic effect on the success of a financial plan, I disagree with the notion that luck has any bearing on the matter because, while we cannot control the markets, we can control our own actions.

In very simple terms the risk of bad "luck" derailing a financial plan can be addressed through proper planning over the life of the plan:

1. reduce equity exposure when values are materially above historical averages - you may miss the end of a bull market but you will also miss the fall in values afterwards and you are cashed up ready to pounce when values get cheaper again;

2. increase equity exposure when values are materially below historical averages and are cheap in absolute terms - sure markets can go down further but history suggests that buying in times of adversity will pay off, it's merely a question of how long you have to wait;

3. plan on retiring a few years earlier. Not only do you have the possibility of spending a few extra years on the golf course if things go well, but you have the flexibility to keep working if things go badly or you want a bit more security.

Points #1 and #2 apply to any asset class, not only equities.

Is it that easy? Possibly not. It requires standing aside from the market when others are boasting about how much money they have made and jumping in when the financial media is spending most of its time showcasing the prophets of doom. It also requires the discipline to save at a higher rate. But if you can manage these three things, at least this component of the luck element can be managed.

And the alternative is what? Just taking your chances? Buying bonds only - at today's yields? Personally, I would rather make the attempt to deal with the issue than ignore it.